It's tax season again! And while it's not typically considered the most wonderful time of the year, for parents, there are a number of things you can do to bring a little bit of joy to the season.
For starters, if you are one of the majority of Canadians expecting to get a tax refund from the government this spring, here's a tip to make that refund grow by 20 per cent (the amount of the federal government's basic Canada Education Savings Grant) or more: put it into a Registered Education Savings Plan (RESP) for your children. In some provinces that could be increased by another 10 per cent! You can get more details on these education savings grants -- including a number of rules you should pay attention to -- here.
But what if you have an RESP and are getting ready to send your child off to university later this year? What do you need to think about as you crack open the vault and tap into those hard-earned savings?
First, you need to pause and pat yourself on the back. Your child is getting ready to go to university AND you have some money set aside to make that possible. As a dad who has reached that point with three of my children (so far!), I can say with conviction that this is no small feat. Well done!
The money in your RESP can be divided into three basic groups: your contributions, government grants and the income earned on both of these. There are some nuances to how all of these are treated for tax purposes, so you should plan how you take the money out of the RESP.
First, the contributions: Remember that the money you put into the RESP is "after-tax" dollars. This means that you didn't get a tax deduction when you put the money in.
More importantly for you now, it means you don't pay tax on it when you take this money out of the RESP. My general advice to parents is to leave the contributions in your RESP as long as you can. There is no tax advantage to take it out unless you actually need it, so why not leave it in the RESP to continue to grow?
Second, the government grants: You actually can't "withdraw" grants by themselves. Grants have to be taken out of the RESP as part of what is called an Education Assistance Payment (or EAP). This can only happen when your child is enrolled in eligible post-secondary education.
To get access to the grants, you actually have to withdraw the income from the plan as an EAP. When you do this, the grants are paid out in proportion to the amount of income you take out of the RESP.
So, if you take 50 per cent of the income out of the Plan, you will also have to take 50 per cent of the grants out of the RESP. This sounds a bit complicated -- but really all you need to do is figure out how much of an EAP you want to take out and your RESP provider will do the math for you to figure out how much is income and how much is grant.
The important thing to remember is that the EAPs are taxable income -- but they are fully taxable in your child's hands at his or her tax rate -- not yours. So when you consider how much to withdraw, evaluate it in the context of what you will need and of any other taxable income your child will receive in the year.
One of your goals should be to try to minimize the potential tax he or she will pay on the EAP. However, you should also remember that you cannot take EAPs more than six months after your child leaves school, so make sure that you have taken all the income and grants out while he or she is in school to minimize the tax impact.
Some RESPs, such as Group RESPs, will automatically divide the EAP payment over up to four years that your child is at school, helping to minimize the potential of paying tax on those EAP amounts.
And then there's the unthinkable for many parents: What if you have saved for years in an RESP and your child has decided post-secondary education is not really for them?
Assuming you have no other children to transfer the plan to, you can still take out your contributions with no tax consequences. When you do this, the government will take back the government grants. But all of the income earned in the plan is available to you, provided you meet certain criteria for what is called an Accumulated Income Payment (or AIP).
Here's the issue with taking an AIP: if you just take the cash it is not only taxed at your tax rate -- there is an additional tax of 20 per cent on the money. Ouch!
You can eliminate that 20 per cent tax hit if you transfer the AIP into your Registered Retirement Savings Plan (or RRSP). But to do this you need to have unused contribution room in the RRSP. So, if you expect to take advantage of this option, you may want to reduce your regular contributions to your RRSP to create the room to transfer the income in from the RESP. Alternatively, if applicable, you can transfer the AIP into an eligible Registered Disability Savings Plan.
Let's be honest: tax season is never a season of joy. But hopefully I have been able to help you navigate some of the ins and outs of RESPs to make it at least a little less painful.
Of course the above should be taken for what it is: the ramblings of a dad who knows a lot about RESPs and who has survived having three kids in university at the same time! As always, be sure to seek tax advice from a professional who can advise you on your specific circumstances.
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